Auto Retailers' Ability to Pay Debt - What It Means

It is no secret that for various reasons, Americans have recently cut back on their spending. Since cars are big-ticket items, this drop in spending has manifested itself with utmost clarity in the auto retail space. U.S. motor vehicle sales were down some 18% in June year over year. As a result, many car retailers have been punished in the market.

Could this create a buying opportunity? Often, cyclical downturns allow long-term investors to pick up decent companies at bargain prices. In the case of auto retailers, when the economy returns to normal, people may not buy trucks and SUVs at the same pace as they had a couple of years ago, but we can nevertheless expect vehicle sales to recover from their current lows. Unfortunately, it's difficult to determine just how long a downturn will last.

Because downturns of unpredictable magnitude occur every few years, value investors tend to prefer buying companies with low debt levels, since these are the most likely to be able to last through a recession and re-emerge from it in strong positions as compared to the competition. Therefore, in these uncertain times, when examining the depressed auto retailing sector, it may be wise to consider which companies must focus on making ends meet just to make their next debt payments, and on the other side, which companies can afford to take advantage of the situation to position themselves for future growth.

With that in mind, here are some major U.S. auto retailers ranked by their interest coverage ratios:

 

From the chart, it appears that both CarMax (KMX) and America's Car-Mart (CRMT) are in a position to outlast their competitors should this be a prolonged downturn. They may even choose to make further investments without risking the viabilities of their companies and thus emerge in better positions than the rest of the group.

At the bottom of the list, we have Lithia (LAD), who swung to a loss last quarter simply due to its interest payments. Management of this company can hardly focus on the long-term health of the company when they are busy trying to find ways to make the next several interest payments.

Even though their interest coverages are somewhat on the low side, the fact is most of the companies lie somewhere in between.  As we've discussed here, Asbury (ABG) is an example of a company that doesn't have a lot of leeway when it comes to making the payments it has committed to make.

Of course, this is only an initial, cursory look at these companies. One still has to dig into the financial statements to make a full and proper assessment, as discussed here. For example, there may have been special items last quarter that caused operating income to be higher or lower than it would otherwise normally be, and this would skew the interest coverage ratio. Nevertheless, this is a good starting point to determine which stocks look safe enough to last through a downturn of unknown magnitude.

Disclosure: None

Comments

[maelstrom:]

The problem with used auto dealers is that every week the cars are worth less and a slow market compounds this. The wholesale auction prices fall an the ripple efffect is started

2008 Jul 24 12:56 PM

[eva:]

Good aproach, but still used car dealers sound very risky. For instance, who ever have a large proportion of SUB's and large pick-ups (gas gustlers) are in great disadvantage because they will not sell unless a real big discount is offerred...

2008 Jul 24 01:28 PM

[billddrummer:]

The Lithia stores in my market (Northern NV) are taking steps to reduce expenses--combining/el... district level supervision (instead of separate dealership managers, one 'area manager' will now supervise 5 stores), relocating dealerships in poor locations (a store with poor access and low traffic counts is moving to a street with the highest surface traffic counts in town, at cheaper rent) and the like.

How long that takes to show up in interest coverage remains to be seen. But at least management isn't asleep at the switch.

2008 Jul 24 04:08 PM

[falcon2382:]

when you see deep pocketed insiders scooping up tremendous numbers of shares as is the case with Auto Nation (with Bill Gates recently purchasing the equivalent of 5% of the company and Eddie lambert's stake now up to 44% after purchasing nearly 10 million shares during the past 6 months alone), I don't think it is that difficult to find the one or two golden eggs on this list above. The others might even be short candidates as they don't have a chance against the experience and money managing skills of Lambert, Jackson, and Gates (and others) at Auto Nation, and Buffet helping out at Karmax. The implied guarantee that these individual investors have given the company by putting their money where their ideas are is powerful, indeed.

2008 Aug 07 02:23 PM

[Saj Karsan:]

Hi Falcon,

Regarding Buffett and Carmax, I'd encourage you to check out this article over at Fortune: money.cnn.com/2007/11/...

2008 Aug 07 04:16 PM